Electronic Commerce Best
Practices

In 1991 the FTA established a Business Taxes
Electronic Filing Task Group (BTTG) to explore technical, legal, and
administrative issues relating to the implementation of electronic
filing of business taxes, leading to the issuance of a 1995 Report
and Recommendations that were adopted by the FTA Board of
Trustees.

An update of that report was initiated at the
Federation of Tax Administrators' annual Technology Conference in
August, 1999. The intent was to create a document that updates the
1995 Report, but that is broader in scope, given the exploding growth
of electronic commerce.

Prepared by the "TIGERS" (Tax Information Group
for EC Requirements Standardization) working group, which includes
state tax administration and industry representation, work sessions
took place bi-monthly. The input received has now been incorporated into this
final document.

FTA suggests that, in providing some historical context for your your continued implementation of tax administration EC
processes, it may be of assistance to
you.

Gale Garriott
Executive Director

ELECTRONIC COMMERCE BEST
PRACTICES

A guide for taxing
authorities

ACKNOWLEDGMENTS

This report was prepared by the "TIGERS"
working group. The effort was initiated at the Federation of Tax
Administrators annual Technology Conference in August, 1999,
and concluded a year later with an open discussion session at the FTA
Technology Conference in August, 2000. Special mention is made of the
following contributors, who drafted material for the various sections
of the document:

Terry Garber, South Carolina Department of
Revenue, who also served as Editor of the document

Jonathan Lyon, Federation of Tax
Administrators

Stan Farmer, Missouri Department of
Revenue

Deb Wise, Pennsylvania Department of
Revenue

Kit Lueder, Mitre Corporation

Tim Blevins, Kansas Department of
Revenue

Jim Wassin, Internal Revenue Service

Bill Shanko, Tennessee Department of
Revenue

Debbie Johnson, Oklahoma Tax
Commission.

Appreciation is also expressed both to the
TIGERS "regulars" and to those who participated at only one or two
working sessions, for their commentary, critique, and contributions.
Thanks to all!

You have been tasked with implementing
Electronic Commerce in your tax and revenue agency. How do you begin
to get your hands around the constantly evolving world of Electronic
Commerce? How many of your current programs fit under this umbrella?
What have you missed? What else should you be doing? How do you fit
it all together?

This report can help you. It represents a
snapshot of the world of "tax Electronic Commerce" or "tax EC" -
Electronic Commerce as it pertains to tax and revenue agencies - in
the year 2000. It highlights the major programs in place in many tax
agencies, and many of the "best practices" that those agencies have
discovered through experience. This is not the "bleeding edge" of
technology; many new and exciting innovations are still to come. This
report contains a working consensus of those "best practices" that
can be implemented today.

The scope of this report includes the various
paperless technologies used for the transmission of information
needed for tax administration or tax return filing purposes. It does
not include paper-based technologies, such as scanning, image
capture, or 2-D barcode, within the current definition of Electronic
Commerce. It does include both the "tried and true" technologies,
such as e-file, and emerging technologies such as XML.

Current Objectives

The intent of this current report is to create
a document that updates the 1995 Federation of Tax Administrators
Business Taxes Task Group Report and Recommendations but is
broader in scope. Its objectives, based on the experience of a
variety of reporting participants, are:

To document tax Electronic Commerce
technologies and methods in use today, including a variety of
approaches

To document "best practices" in tax
Electronic Commerce, based on the experience of tax authorities
contributing to this report

To raise issues for agencies to consider in
the implementation of tax Electronic Commerce with their
customers

To suggest areas for cooperation among tax
agencies

To make recommendations that may facilitate
and encourage more rapid mass adoption of tax Electronic Commerce
by their customers.

Use of Electronic Tax Processing
Technologies

There are a number of methods employed today by
tax agencies to capture tax return and payment data electronically.
Additionally, electronic methods are increasingly being used for
administrative functions, such as business tax registration, and name
and address changes for both businesses and individuals.

In order to clearly address the distinctions
among various electronic channel alternatives, it must be clarified
that there is a difference between the communications vehicle, or
mode of transmission of the data from the sender to the receiver, and
the form that the data takes (although in each case data is
electronically captured). The choices made by a tax agency among
transmission method and data format can greatly affect a states
implementation strategy, in no small part due to the varying
capabilities of their targeted filer demographic.

These choices may determine the timeliness with
which the agency can implement the application, the degree of
necessity of a commitment to working with other tax authorities
jointly, the responsiveness of the tax filing community to agency
efforts to promote electronic reporting, the need for additional data
security measures, and a host of other considerations.

Todays Solutions

The one main lesson that has been learned by
taxing authorities who have made the investment in tax EC is that one
size doesnt fit all. Tax EC programs vary widely in scope and
complexity. Taxpayers vary widely in their readiness to accept and
utilize new technologies. For these reasons, "best practices" today
recognize that there is no one single technology solution for taxing
authorities. Each of the major areas of current and emerging EC
technology used in the tax filing and payment and tax administration
processes will be covered in Part II, with recommendations for
targeting each technology to the most appropriate segment of the
taxpayer community. These include:

Internet

E-file, especially Fed/State filing
programs

Interactive Voice Response
(IVR)

Electronic Data Interchange
(EDI)

Payment Methods

Communications Technologies

Extensible Markup Language
(XML).

Part III will cover key business issues that
have arisen in connection with Electronic Commerce,
including:

Marketing

Who provides the program? The role of
market vs. In-house development

Legal and compliance issues.

Part IV revisits nineteen business issues
examined in 1995 by the Business Taxes Task Group. Here they are
broadened to include individual as well as business taxes, and to
include newer technologies. However, these issues are surprisingly
relevant in 2000, and are still worthy of consideration.

Background

A background history of the Federation of Tax
Administrators activities in Electronic Commerce, beginning
long before the term came into popular use, chronicles the adoption
of EC technologies in the tax and revenue community.

The phenomenon of electronic filing of tax
returns and electronic payment of tax liability has been well
documented since the Internal Revenue Service implemented its
proprietary Individual Income Tax electronic filing system in 1985
and the state of Indiana enacted legislation mandating certain
electronic funds transfer (EFT) payments in 1987.

The Federation of Tax Administrators was
organized in 1937 as a nonprofit corporation to improve the
techniques of tax administrators and the work of their profession,
and to advance the standards of tax administration. The tax
departments of the 50 states, the District of Columbia, and New York
City are the members of the Federation of Tax Administrators. The
Commissioner of the Internal Revenue is an ex-officio board
member.

For well over a decade, the Federation of Tax
Administrators (FTA) has been extensively involved in developing and
coordinating projects which facilitate the application of emerging
technologies for use in tax administration:

Starting in 1988, the FTA, assisted by
other interested parties, developed payment format standards,
provided EFT program implementation recommendations in 1990, and
continues to monitor the 46 state implementations of
EFT.

Beginning in 1989, the FTA and the IRS
worked together with the state taxing authorities over a number of
years to implement a Fed/State Electronic Filing program for
individual income tax filers. This has grown to encompass 39
states.

In 1990 the FTA and Multi-State Tax
Commission (MTC) formed the TaxNet Governmental Communication
Corporation (TGCC) which provides electronic services for member
organizations.

In 1991 the FTA established a Business
Taxes Electronic Filing Task Group (BTTG) to explore technical,
legal, and administrative issues relating to the implementation of
electronic filing of business taxes through the use of Electronic
Data Interchange (EDI). This led to the issuance of a 1995 Report
and Recommendations adopted by the FTA Board of
Trustees.

In 1994 the FTA, together with the IRS and
several founding states, created the "TIGERS" workgroup, the "Tax
Implementation Group for EDI Requirements Standardization."
TIGERS initial charge was to develop standards across
federal and state taxing authorities for the use of EDI data
formats. Working as a task group within ANSI Accredited Standards
Committee X12, TIGERS published two important documents, the "EDI
Business Reference Model for Taxing Authorities" and the "EDI
Technical Reference Model for Taxing Authorities."

TIGERS charter broadened in 1999 to
embrace multiple Electronic Commerce technologies, changing its
acronym "E" from "EDI" to "E-Commerce," but the group continues to
work towards the development of data standards and consensus
conventions across multiple agencies. Current work includes the
investigation of XML standards for tax administration within the
Internet environment.

The mission of the BTTG was to serve as a focal
point for input to the FTA Board of Trustees in working with the
business community regarding the filing of tax returns and
information by other than paper means. In addition, it assisted the
education efforts which increased FTA member awareness of initiatives
in the area of EDI-based electronic tax filing. The resulting
Report and Recommendations therefore addressed only business
taxes, and EDI was the only electronic filing technology discussed.
Clearly a new report was needed to cover the new universe of tax
EC.

Today

Over the past five years, a variety of other
"Electronic Commerce" (EC) methods, technologies, and communications
channels designed to enable electronic processing have been applied
to the filing and payment of taxes, including Telefile, the Internet,
and others. These have expanded the opportunities available to states
to do business with individuals and businesses
electronically.

At the same time, the use of these modes has
motivated states to introduce similarly innovative approaches to the
business issues raised by the use of electronics, for example in the
areas of authentication, acknowledgment of filings, and the treatment
of filing intermediaries/transmitters.

These developments present the opportunity to
craft new guidance for tax administrators that takes into account
both the wide range of new utility available to them, and the need to
employ it in each instance with some consideration to consistency
across tax jurisdictions.

PART II - THE TAX ELECTRONIC COMMERCE
UNIVERSE OF 2000

Section 1 -
Internet

Where is the Internet Best
Used?

Today, in 2000, the world is in love with the
Internet. In theory, it seems that the types of applications that can
be deployed using the Internet are limitless. In fact, the Internet
may be used in two distinct ways. First, the Internet is a
communications network connecting many different locations. It may be
used simply as a network, that is, to transport data files and
messages between point A and point B. In this way, the Internet
provides a low-cost alternative to commercial networks; this will be
discussed in greater length in Section 6.

The incredible flexibility of the Internet,
however, lies in the second ability to create interactive
applications combining text, data, and graphics, connecting to
background data bases as needed, and presenting an intuitive, "user
friendly" interface to the taxpayer. This ability enables a taxing
authority to build interactive filing programs for fairly complex tax
filings, as well as for administrative functions such as taxpayer
registration, account maintenance, and refund status
tracking.

Internet Readiness

The Internet is the fastest growing vehicle for
electronic transactions of any kind. Much has been written on the
phenomenal growth of Internet usage over the past decade. However, in
most states, the number of households with Internet access hovers in
the range of 30% - 50%. It is clear that use of the Internet at this
time should be one of multiple options for service provided to
individuals and businesses. At the same time, the use of the Internet
is becoming the method of choice for those who have access to it, and
that choice should be leveraged wherever possible.

At minimum, all tax authorities should provide
general information to the public via a website. The website should
also include downloadable tax forms, generally in PDF format, plus
tax law, rulings, and regulations in a searchable format.

Internet Tax Filing

There are two basic approaches to tax filing
over the Internet: interactive filing and batch filing. In
interactive filing, the taxpayer interacts directly with a web-based
application to complete the tax filing online. Focus groups have
shown that taxpayers in general prefer a conversational
question-and-answer format, customized to the taxpayers filing
history, with pull-down selections where appropriate, to
fill-in-the-blanks applications where a paper tax form is simply
reproduced on the web display. When the information is complete, the
taxpayer submits the filing for processing. Payment information, such
as bank accounts for direct debit payments or direct deposit of
refunds, or credit card information, may be combined with the tax
filing application.

Within the interactive method of Internet
filing, there are two alternative technologies. In one, the taxpayer
interacts directly with the web server hosted by the tax authority or
a third party, with only a web browser on the taxpayers
machine. Advantages of this approach include the ability to support a
variety of taxpayer hardware and software configurations with the
single host application, as well as the ability to update the host
application at will without concern for what version is on the
taxpayers machine. Disadvantages include the need for the
taxpayer to remain connected to the host website throughout the
entire transaction. Taxing authorities must also take care to support
multiple releases of the most common Internet browsers. The second
alternative has the taxpayer download tax preparation software from
the website to the taxpayers machine. The taxpayer completes
the filing offline, then reconnects to the host website to upload the
completed filing. Advantages of this method include the ability of
the taxpayer to store the filing on the taxpayers machine for
future reference, as well as the ability to interrupt the filing for
other activities, and return to it at a later time. Disadvantages
include the need to accommodate various versions of the software to
match taxpayer hardware and software configurations, and the need for
customer assistance staff to support the download and installation
processes. At this time, both approaches are being offered, both by
tax authorities and third-party service providers; neither has gained
dominance in the marketplace.

In Internet batch filing, the Internet is
simply utilized as the network over which a tax filing is
transmitted. The tax filing has been created offline as a data file
by some form of software program, either a generalized program such
as a spreadsheet, or a specialized tax preparation package. For very
large data files, such as those created by a large filing such as
Motor Fuel or some Motor Carrier Fuel Use (International Fuel Tax
Agreement - IFTA) programs, or multiple filings from a payroll
processor, the file transfer protocol (FTP) is recommended. Since FTP
requires special software and some knowledge of computer
transmissions, it may not be the best method for smaller returns and
smaller businesses or individuals. In those cases, it may be possible
to transmit the tax filing simply as an attachment to an electronic
mail message. However, there are concerns with both the security and
the reliability of such an approach.

Internet-Based Tax
Administration

The use of the Internet for tax administrative
functions other than tax filing is steadily growing. Most taxing
authorities now provide copies of their forms, in downloadable
format, on their websites. Many offer online inquiry into the status
of individual income tax refunds. The more advanced administrative
uses of the Internet, however, center on the areas of account
maintenance and customer service.

Account maintenance includes taxpayer
registration, name and address changes, the ability to check account
balances and outstanding liabilities, and the ability to pay
outstanding balances online. The movement is toward self-maintenance,
that is, the taxpayer actively maintains the information in his own
account, rather than having to provide the information to tax
authority personnel. Self-maintenance increases accuracy, by
eliminating third-party keying of data. It can be made available at
the taxpayers convenience, seven days a week, 24 hours a
day.

Customer service refers to the response to
inquiries and requests from various customers, including taxpayers,
tax practitioners, and other third parties. In addition to general
information, taxing authorities are beginning to maintain Frequently
Asked Questions (FAQs) on a variety of tax topics in a format that is
simple for the customer to navigate. Best practices also include
linking the website to the taxing authoritys electronic mail
system, so that the customer can enter e-mail directly from the
website, targeted to the specific area capable of responding to a
particular subject area. Taxing authorities should set a strict time
limit for responding to e-mail inquiries, preferably within 24 hours
of receipt. Automated systems can route and distribute e-mail, track
responses, and escalate if the e-mail is not answered within a
specified time limit. Care must be taken to ensure that the
information provided over the Internet to the taxpayer is the same as
that provided by other means, such as Interactive Voice Response
(IVR) or direct taxpayer service phone line.

Internet-enabled tax administrative functions
may be provided by a taxing authority on a stand-alone basis, or they
may be part of a state-wide "portal" for citizen access. The move to
state portals is discussed in more detail in part III, section
4.

Internet Security

Because it is a public medium, the Internet is
only as secure as each application provider, including the taxing
authority, chooses to make it. Newspapers report incidents of
"hackers" compromising the credit card numbers of electronic commerce
customers. In any Internet-based tax filing program, care must be
taken to protect confidential tax data, and to build the
taxpayers confidence in the security of the filing
program.

De facto standards for the security of
interactive web-based applications at the time of this report include
the use of PINs or passwords, and the use of secured socket layer
(SSL) so that the transmission can only be read by the sender and the
intended receiver. PINs are issued to taxpayers by an independent
method (usually paper mail) and are verified against a database by
the Internet application. Secured socket layer requires the host
website (tax authority or third party) to have obtained a "digital
certificate" from a "certificate authority." This digital certificate
provides the host with a pair of encryption keys, related by a
complex mathematical formula. One key, the "public key," is published
by the certificate authority, who certifies that this is the public
key for the host party. The other key, the "private key," is kept
confidential by the host. When the taxpayer interacts with the
website, the web application initiates an SSL session. The host
provides its public key, which is verified by the certificate
authority. The taxpayers web browser then uses that public key
to encrypt all data that it sends to the host. In this way, only the
host, using its private key, can decrypt the data.

Although SSL provides some measure of security
for Internet transmissions, it does not authenticate the sender. PINs
can be stolen from the mail or lost or compromised by the taxpayer.
In order for electronic commerce over the Internet to mature, there
must be some readily available and reliable means of authentication
for all parties. Many believe that a network of certificate
authorities, known as a "public key infrastructure" or PKI, will make
public/private key encryption inexpensive and universally utilized.
Some tax authorities are considering becoming certificate authorities
themselves, and assigning key pairs to taxpayers at no charge. These
keys may reside on a server or personal computer, or they may reside
on a card or some form of token, which must be read at every
transaction to "sign" it. Others believe that biometric forms of
security and authentication, which utilize a unique biological
identification such as a fingerprint or retinal scan, will become
inexpensive and widely used. At the time of this report, however,
there is no universally accepted means of Internet authentication.
The IRS and several states have piloted PKI applications with some
success, but have reported concerns regarding the publics
ability to correctly install and maintain digital certificates, and
regarding the identification of each certificate with a server
(machine) rather than an individual.

In the case of batch Internet transmissions,
whether FTP or e-mail, encryption is also encouraged. Software such
as "Pretty Good Privacy" (PGP) and "Norton Secret Stuff" can provide
encryption capabilities at low cost. However, the issue of encryption
key management - the exchange of keys so that they are known to both
parties - can be cumbersome, especially when a tax authority must
maintain the keys of multiple trading partners.

Tax authorities must also provide protection
for the databases used in Internet transactions, since they contain
confidential taxpayer information. Specialized servers with software
known as "firewalls" are used to provide a logical barrier between
the tax authoritys data and the outside world. A firewall is
used to protect a user community, or enclave, from threats
originating from an external network, typically the Internet. A
firewall is placed between two networks, and is essential for an
interconnection between a private network and the Internet. A
firewall acts to filter out undesirable network activity based upon a
security policy instituted by the organization controlling the
firewall. The filtering is not symmetric, in that traffic entering
the enclave is filtered, while traffic going out to the Internet is
typically not filtered (or not as stringently).

Finally, it should be noted that the Internet
is not reliable, that is, there is no guarantee that any particular
message will reach its destination. For that reason, it is imperative
that tax authorities build some form of acknowledgement mechanism
into all Internet filing programs. For interactive programs, that
often takes the form of a confirmation number provided to the
taxpayer. For EDI over the Internet, it may take the form of a
traditional EDI acknowledgment transaction set. The taxpayer should
be educated to understand that the tax filing has not been completed
until the confirmation number or acknowledgment is received in
return.

Role of the Webmaster

Due to the rapid evolution of the Internet, it
has not been unusual for a Web enthusiast to take on the role of
Webmaster, without training or preparation. Best practices call for a
taxing authority to support the training, skills, knowledge, and
proper tools of its Webmaster. It must be recognized that there are
three distinct roles that must be filled in the Internet
environment:

Technical support for the Internet,
including the installation and maintenance of servers, firewalls,
and other Internet-related technology;

Content management, which includes
providing information to be distributed over the Internet, such as
tax rulings and policy documents, and ensuring that the
information is accurate and up to date; and

Support of Web applications, such as tax
filing, which may include the design and programming of computer
systems that run in the Internet environment.

Generally the Webmaster provides the technical
support, and serves as coordinator to ensure that the Web content and
applications work together to provide a coherent Web site. Best
practices place the responsibility for Web content with the content
"owners" within the taxing authority, and provide the means and onus
for keeping the content current and accurate. Webmasters should try
to keep aware of current technology trends, and to promote open
standards wherever possible.

Technical Considerations for Batch Internet
Filing

File Transfer Protocol (FTP)

File Transfer Protocol (FTP) is an Internet
protocol that allows a trading partner to copy files from one
computer node to another. FTP is very cost effective for large,
voluminous filings such as Motor Fuel tax. Care must be taken to size
the FTP server to accommodate anticipated numbers of tax
filers.

E-Mail

E-mail is a method for performing push-based
message transfer to the recipient. Utilizing the Internet, there is
concern with quality of service and confirmed delivery, unless
measures are taken by the tax authority. E-mail security capabilities
can be handled in two ways. Option One: The entire e-mail
message, including the attached reporting file, can be encrypted.
Using encryption, the state entity holds a private key and
distributes their public key to interested trading partners. This
allows for an exchange of files that are secure to pass from one
trading partner to the next. To do this both the state entity and the
trading partner must have compatible e-mail systems. Information on
encryption can be obtained from any encryption capability provider.
Option Two: Only the reporting file is encrypted, and attached
to a non-encrypted e-mail message.

There are two common models for the
communication infrastructure for e-mail applications. These models
are a) direct receipt of the file, and b) utilizing a VAN to receive
the file. The file can be e-mailed directly to the state agency.
Depending on whether the file is encrypted or not, the agency may be
required to maintain a separate server to receive, decode, translate,
reformat and upload the file into the regular processing system.
Alternatively, the file can be e-mailed to a VAN or other service
provider for translating, reformatting and forwarding to the state
agency.

Section 2 - E-file,
Especially Fed/State Programs

Where is E-file Best Used?

The term "e-file" is used here to include IRS
electronic filing programs, and state electronic filing programs that
leverage the facilities and capabilities of those IRS initiatives,
particularly for Individual Income tax returns. E-file is the EC
technology of choice in three environments:

The taxpayer wishes to file both federal
and state returns, and can do it together

The taxpayer uses a professional tax
preparer, who is classified as an "electronic return originator"
("ERO") for e-file

The taxpayer uses a commercial "off the
shelf" tax preparation software package for the taxpayers
home computer.

ELF and OLF

In sharp contrast to the sense of "newness"
that surrounds the Internet, the process now referred to as "e-file"
has existed since its introduction by the IRS in 1987. In the
original form of e-file, also called simply "electronic filing" or
"ELF," a tax preparer enters tax return data into a software program,
which converts the data into a specific proprietary format created by
the IRS. The formatted return file is then transmitted to the IRS,
often over a dial-up modem connection. In Fed/State e-file, which was
introduced in 1991, a state tax return is concatenated onto the
federal return, again in a proprietary IRS format. The state tax
authority then downloads the state returns, via phone line and modem,
from the IRS into its own computer systems. Once the preparer has
entered all of the data for the federal tax return, the software can
easily add the calculation of the state return. The state, then, has
only a relatively small investment to participate, needing only to
download the returns and translate them into its internal format for
further processing.

ELF cannot be ignored in a discussion of tax
EC, because for most states it is still the single largest source of
electronic tax returns. In recent years the IRS has noticeably
stepped up its marketing of ELF, and tax preparers have reduced the
cost of electronic filing. For these reasons, and its reputation for
rapid refunds, ELF continues to grow.

The fastest growing form of e-file is referred
to as "online filing" or "OLF." In one form of OLF, a taxpayer
purchases a tax preparation software package from a major commercial
vendor. The taxpayer uses the software on his or her home PC, and
sends the tax return data, via phone line and modem, to the software
vendors own facility. In the newest form of OLF, the taxpayer
simply logs onto the software vendors website over the
Internet, and either completes the tax filing interactively, or else
downloads the software package onto the home PC from the Website. The
completed return is then uploaded to the vendors website. In
either case, the vendor then converts the tax return data into the
proprietary IRS format and transmits it to the IRS, where it is
handled the same as any other ELF return. Many vendors support the
Fed/State filing program, and include state filing in their
software.

Software vendors competing in the marketplace
can provide online assistance with tax filing, and other ease-of-use
features which may not be cost justifiable for a state to develop in
its own programs. They support the filing of both federal and state
returns in a single transaction. They also have brand recognition.
States should leverage these capabilities to encourage OLF as a
low-cost EC technology.

Direct Filing

Some states have chosen to implement direct
non-Internet individual income tax filing programs, rather than to
support the Fed-State program. The advantages of direct filing are
primarily those of control; the taxing authority can control the
sources of the returns, the manner of filing, and whether the returns
are accepted or rejected. Direct filing programs make it possible for
a tax return to be refiled directly with the state, even if it is
rejected by the IRS. Direct filing programs generally use proprietary
data formats, so that they can be tailored to the taxing
authoritys specific needs.

The disadvantages of direct filing are those of
participation. Except in the largest states, software vendors
hesitate to support proprietary formats unique to a single taxing
authority. For this reason, taxing authorities offering direct filing
programs often develop and provide their own software to taxpayers.
Tax practitioners are also less likely to support direct filing
programs, since it requires separate transmissions for the federal
and state returns.

Business E-file

To date, e-file programs have addressed
primarily individual income tax. It should be noted, however, that
there have been several initiatives to address business e-file,
particularly of federal and state employer withholding taxes. The
Simplified Tax And Wage Reporting System (STAWRS), a multi-agency
initiative, promotes the combined filing of federal and state
withholding and unemployment insurance reporting requirements,
meeting the needs of the IRS, Department of Labor, Social Security
Administration, state tax authority, and state employment security
authority. These programs are still in the development stages, but
should be noted as future opportunities.

Section 3 - Interactive
Voice Response (IVR)

Where is IVR Best Used?

Many taxpayers do not have the technological
equipment or experience to use computers to interact with tax
authorities. In these instances the tax authority must decide between
processing paper and offering other alternatives. One popular
alternative is the use of interactive voice response (IVR)
technology.

IVR uses a touch-tone telephone as an
input/output device. The taxpayer uses the keypad to enter
information when prompted by the script being played through the
telephone. Based on the data entered, the system confirms data
entered and returns answers to questions. So essentially, IVR is a
form of electronic filing and inquiry. There are numerous
applications that can be employed using the IVR. The following
discussion outlines some of the more prevalent uses.

A basic application is using the telephone to
inquire about the status of a return or refund. The taxpayer enters
basic information such as a tax identification number and amount of
expected refund. The tax authority uses that information to inquire
its database and return the status of the refund claim. For example,
if the refund claim has been processed and the refund check is due to
be mailed, the taxpayer would be given the refund mailing
date.

IVR for Tax Filing

Another popular use is for filing returns,
commonly referred to as "Telefile." The most popular returns filed
are income tax returns expecting a refund. However, zero due sales
and withholding returns are also commonly filed using the IVR.
Additionally, when coupled with some form of payment reconciliation,
the IVR can accept balance due returns of many types quite
efficiently. The IVR can accept financial account information for
direct debit payments or for deposit of refunds. It is also possible
to interface real-time credit card authorization to an IVR
application, to allow the system to accept credit card tax payments.
IVR is also being used for some specialized tax applications, such as
authorizations for shipment diversions for Motor Fuel tax.

Tax authorities have targeted Telefile programs
to specific audiences, such as college students, military, the
retired community, and, for business IVR filings, seasonal
businesses. In general, these target audiences file simple returns,
without many deductions, credits, and other tax detail, and would use
"EZ" type forms if filing on paper. In order to encourage the use of
the IVR system, tax authorities often send special Telefile booklets
to the target audience, based on patterns of previous years
filings. These booklets contain personal identification numbers
(PINs) for use with the IVR, and worksheets designed to guide the
taxpayer through the simple Telefile process. As an incentive, tax
authorities are now omitting the paper filing forms from the Telefile
booklet, so that the taxpayer must go through an additional effort to
obtain the forms in order to file on paper.

Other IVR Applications

IVR is a convenient, comparatively low-cost
platform for a variety of applications which require a small amount
of data entry by the taxpayer. Various account status inquiries may
be made via IVR. If business tax filing is offered via IVR, such as
zero due sales and withholding returns, then the processes of
registration and PIN selection for these programs may also be offered
in the same way. IVR is currently being utilized by state taxing
authorities for applications ranging from payment of outstanding
liabilities by ACH debit or credit card, to the creation of
installment payment agreements, to authorizing motor fuel diversions.
Faxback is another class of IVR applications; the taxpayer enters a
fax number and selects information requested, such as a particular
tax form. The requested form or information is then sent by return
fax to the telephone number that was entered.

A related technology is that of the Automated
Call Distribution system, or ACD. The ACD works with the IVR to route
incoming calls. Those calls that can be handled by automated response
remain with the IVR system, while calls requiring more detailed
response are routed to call center staff. The ACD tracks calls,
provides queuing and wait time management, and provides reporting
information on such factors as wait time, duration of calls, and
staff loading.

Considerations for IVR
Implementation

One guiding principle to keep in mind is the
length of the telephone call. If a tax authority and a taxpayer are
willing to have a call long enough, almost anything can be done using
this technology. However, neither party is willing to use this
application for tax returns that contain a significant amount of
data. For example, few taxpayers or tax authorities would be willing
to pay for a telephone call long enough in duration to capture a
sales tax return with hundreds of locations and data elements. A
common "rule of thumb" is that an IVR transaction should be completed
in ten minutes or less. Likewise, entering letters using a telephone
keypad is possible, but is tedious at best. Therefore, applications
that require a significant use of letters will likely be time
consuming and error prone which again means neither the taxpayer nor
tax authority will be pleased with the result of this type of
implementation. Therefore, the size and complexity of a return often
dictates whether it is practical to use IVR to file that
return.

Many states and the Internal Revenue Service
have implemented IVR systems to file simple income tax returns.
Likewise, many states have employed IVR for both employer withholding
and sales tax returns. As stated earlier, the time it takes to file
the return is a significant factor.

Most tax authorities now use IVR technology to
provide general tax information to callers. It is tempting to the tax
authority to utilize the "branching" capability of IVR menus to allow
the caller to specify the exact information requested. However,
experience has shown that the IVR inquiry system should be limited to
three options at a time, and only three layers deep, with options to
move back up the "tree." Otherwise, callers will abandon the inquiry
before obtaining the desired information. It is also recommended that
in an inquiry/response application, the system provide the caller
with the option to "opt out" of the system to a live person for
individual assistance, although this option is not recommended for
Telefile applications.

There is no clear consensus over who should pay
for the calls. At this time, some tax authorities utilize toll free
telephone calls for taxpayers outside of the immediate area where the
IVR system is located, and some do not. A toll free number reduces
the cost of the taxpayers compliance with the law, but costs
the state more. However, some applications are so convenient, the
taxpayer is willing to pay to use it. As with many electronic
programs, if it is optional, the lower the cost the more likely
taxpayers are to use it.

Business Models

An additional consideration is how to install
an IVR. There are two basic models. One model has the tax authority
owning and maintaining the hardware and software, the other is the
purchase of a service only. Each model has its own pros and cons.
Under the ownership model the tax authority invests in the purchase
and development of the system either in house or from a vendor. The
only ongoing costs are maintenance and upgrades of the system. In the
service option, the vendor develops and maintains the system with
limited up front cost to the tax authority. The tax authority then
pays for usage of the system either by transaction or by the minute.
Which is the best approach depends on the needs and desires of the
tax authority. A complete financial and business analysis should be
completed prior to committing to either approach.

There are several models for implementing
technology that usually involves a third party technology provider
that is focused on IVR implementations.

Business Model One: This model
outsources all components of the application including development,
testing, and management of the application. This business model has
all areas of the operation outsourced and simply returns the ongoing
data from the application to the customer or tax agency in the
electronic format of their choice. This return of electronic data can
be transmitted using several transmission service techniques
including virtual private network (VPN), Value Added network (VAN),
File Transfer Protocol (FTP) over the Internet, FTP over dedicated
line to a dial up modem bank or communication server, etc.

Business Model Two: This business model
only outsources the software development and testing component of the
application. This development is traditionally done off site at the
IVR vendor development center of choice and either has software
installed on site or through remote telecommunications connectivity.
This development could be done at the customer site if there is
concern about off site development. Using this model the customer
uses this as a knowledge transfer tool in order to train in-house
staff in IVR software development. This model develops the software
development skills to create these applications with only internal
information technology staff. The technology architecture used to
platform this application (includes software, server hardware,
telecommunications infrastructure equipment ) is implemented,
managed, and maintained by the end user internal support staff or
outsourced for on site maintenance.

Business Model Three: This business
model does not outsource any software development and testing
components of the application. Traditionally, the internal
information technology staff completes the work without vendor
assistance. The development project for one tax filing application is
used as a knowledge transfer tool in order to position internal staff
in IVR software development.

Technical Considerations

Taxing authorities must size the incoming phone
line environment to have sufficient capacity to handle the volume of
calls and not become overwhelmed with incoming tax filers. For
specific sizing issues, the IVR service provider or local Telephone
Company from whom the communication lines are leased can generally
provide capacity planning assistance.

There are two common models for the
communications infrastructure for TeleFile applications. These models
are:

The on premise based system provides for sole
source consistency, controlled processing, service value to the
customers, and confidence through ownership. The ability to have a
sole source of consistency makes support and maintenance justifiable
to the vendor. Having the system on premise also gives the agency the
ability to control the processing, giving the ability to facilitate
frequent and sudden changes to the daily operations of the system.
Supplying taxpayers with prompt solutions utilizing a single point of
contact also adds value to the service. With only one phone call,
taxpayer information can be checked and inaccuracies corrected. The
taxing authority gains knowledge and confidence from the ownership of
the system while also reducing the cost of ownership to the agency
through fewer maintenance and support calls to the vendor.

The off premise based system provides for an
initial low cost of implementation and an increased availability of
the system. The initial low cost of implementation is due to hardware
and leased line installation, paid for by the vendor. The total cost
of implementing a system off premise is higher due to cost of support
and leasing of equipment. Secondly, the system availability is
increased because of constant, knowledgeable monitoring. When an off
premise system does have a problem the response time is short and the
system is repaired quickly.

The important aspect of creating an IVR system
is planning for peak usage. An IVR has limited resources and
therefore these resources must be allocated to maintain availability
of the system at peak loads. The IVR is not a high volume system for
receiving a lot of data quickly, the limited number of phone lines
and slow transmission speed of the information creates a bottleneck
that can only be fixed by adding more costly lines. Determining the
number of lines that you need will be based on the total number of
possible filers and the estimated number of filers calling at
peak.

The emerging voice recognition technology is
likely to change or eliminate some of the constraints seen in many of
todays applications. For example, if a person can verbally
spell a word instead of entering it on the keypad, the use of the IVR
can be expanded somewhat. The voice recognition could also speed the
use of the system because it may be quicker for someone to speak the
numbers than use the keypad. As with most technologies at the time of
this report, this one is changing rapidly.

Section 4 - Electronic Data
Interchange (EDI)

Where is EDI Best Used?

EDI is the computer application to computer
application transmission of information in a standardized format. EDI
standards are set by consensus bodies such as the ANSI Accredited
Standards Committee X12. EDI is best used in the following
situations:

Large volume transmitters - EDI is
conducive to large volumes of data

Self-programmers - e.g., businesses and
software vendors who have committed the resources to implement
EDI

Third party bulk filers - e.g., payroll
service providers are highly automated and are the largest single
sources of tax filings.

Batch applications - where real-time
response is not expected

Industry segments with a large investment
in EDI - e.g., Motor Fuel taxpayers

Prior to the recent emergence of new electronic
technologies to transact business, EDI was the best way for a
business to reduce its paper processing cost, as well as the costs,
errors and time delays associated with data entry. As large
corporations and their smaller customers and suppliers implemented
EDI in the mid-1980s and 1990s, it seemed that the use of
EDI for tax filing was a natural extension of a major business
trend.

With the rapid increase in the use of other
electronic commerce technologies for business transactions, such as
Interactive Voice Response (IVR) and particularly the Internet, EDI
is now seen as only one out of a number of valid alternatives. The
emergence of these electronic technologies has forced tax authorities
to face the reality of providing and supporting multiple electronic
filing options to its tax filing population. In addition, multiple
electronic filing options are now necessary in order to reach the
level of electronic activity that tax authorities need to realize the
cost savings and other advantages associated with electronic
filing.

Because specialized computer software is needed
to translate business information into EDI format before
transmission, small to mid-size businesses are intimidated by the
investment of time, effort and costs that seem necessary to implement
and maintain EDI for tax filings. Electronic filing software
developed by a software vendor or tax authority can make EDI a viable
option for small to mid-size businesses. With these electronic filing
options, businesses do not need to invest their own time, effort and
costs in implementing EDI, because the EDI technology is embedded in
the tax filing software. They do not need to know anything about the
technical specifications involved in creating an EDI-formatted data
file. This group of filers, however, would also lend itself to
Internet and IVR filing applications.

Overcoming Perceived Barriers

EDI is generally seen as complex and costly to
implement. As noted above, specialized software is needed to
translate data into EDI format, and programmer time is needed to
configure the translation. A number of tax software vendors are
developing tax filing software which produces an EDI-formatted output
file, ready for transmission. This software reduces the perceived
complexity of EDI by making the translation transparent to the user.
However, smaller taxpayers protest the need to spend money on
software to replace paper processes which can be completed for the
cost of a first-class postage stamp. In particular, neither tax
authorities nor taxpayers feel that an EDI program can be mandated
when costs are incurred by the taxpayer.

Taxing authorities have addressed the cost of
EDI software in two ways. Some have partnered with software vendors
to provide the tax filing software at no cost to the taxpayer. Others
have undertaken the development of EDI tax filing software
themselves, and provided the in-house written software to the
taxpayers. In either case, the tax authority must weigh the cost of
such a program with the benefits in reduced paper handling and
reduced error rate that are achieved through the use of
EDI.

The second area of cost and complexity in EDI
is the transmission of the tax data from the taxpayer to the tax
authority. EDI has traditionally made use of the "value added
network" (VAN) for data transmission. Both tax authority and
taxpayers maintain "mailboxes" provided by the VAN. The taxpayer
transmits EDI tax filings to the tax authoritys mailbox, and
receives acknowledgements in the taxpayers mailbox. The
advantages of the VAN is that the tax authority need only maintain
the one communications interface, that of the mailbox. It does not
have to maintain communications lines to support a large volume of
taxpayer calls, nor does it have to support a variety of
communications speeds and protocols. The VAN also enforces the
security of the transmissions. However, VAN costs generally include
not only the monthly mailbox fee, but also the costs of the toll
calls and a per-character transmission charge. Many taxing
authorities have justified paying the toll and transmission charges
for all taxpayers in its EDI program. Some even pay the
taxpayers mailbox fees.

Tax authorities need to undertake the
obligation to see that participating businesses are equipped to
handle EDI with minimal effort and expense. When working with tax
filers to overcome these barriers, an effort must be made to create a
"win-win" situation. Understanding the concerns of tax filers such as
readiness and cost will allow tax authorities to tailor the program
to minimize concerns and attract program participants.

The number of parties involved in the process,
the possibility of tax filer needs to alter their computer systems,
and the need for taxpayer education and assistance programs are other
factors that need to be considered when addressing taxpayer
capabilities and costs.

EDI Over the Internet

The Internet is now being seen as a low-cost
alternative to the value added network. However, as was discussed
more fully in Section 1, the Internet is not a single technology, but
a medium for a variety of approaches. These can range from
interactive solutions which enable the taxpayer to interact directly
with the tax authoritys website, creating EDI-formatted data on
the back end, to solutions in which a traditional EDI file is
generated and then simply attached to an electronic mail message to
the tax authority. The only consensus at this time is that use of the
Internet may make EDI programs more attractive by eliminating many of
the traditional VAN costs.

At the time of this report, however, the
Internet is not as secure or reliable as a VAN, unless additional
steps are taken. Internet EDI programs must utilize additional
procedures to insure that the EDI data reaches its intended
destination, without delay, corruption, or interception. Many
commercial VANs are reinventing themselves as Internet Service
Providers, utilizing the cost savings of the Internet for EDI
transmission, but utilizing the functionality of EDI to provide the
resources to ensure security and reliability of customers
transactions.

Where Can You Get Help in Implementing
EDI?

A convention is a set of rules created by an
industry-related organization. Conventions supplement EDI standards
by providing specific implementation parameters in specific settings
(e.g., conventions related specifically to sales tax or employer
withholding tax). Conventions are enforced through peer pressure and
mutual agreement on the business advantages of consensus. Conventions
are important to tax filers, tax authorities, software vendors and
value added networks. Conventions decrease taxpayer burden, exception
handling, and difficulty to software vendors and value added
networks. All parties are economically dependent on consistency of
implementation across multiple taxing authorities. Because the EDI
standards themselves are so generic, the lack of consensus
conventions can make the implementation of EDI across multiple taxing
authorities as diverse as proprietary data formats.

One of the industry-related organizations that
develop conventions for tax-related applications is the Tax
Implementation Group for EC Requirements Standardization (TIGERS).
TIGERS is a working group of states, IRS, and business and service
provider representatives to promote and review opportunities for
consistency and uniformity between state and federal EDI conventions.
The work group has accomplished to date:

The publication of the EDI Business
Reference Model for Taxing Authorities - Volume 1. This volume
contains business issues for tax authorities implementing an EDI
Program.

The publication of the EDI Technical
Reference Model for Taxing Authorities - Volume 2. This volume
contains recommendations on the use of tax-related conventions and
all other technical issues involved in the implementation of EDI
tax-related filings.

For further information on EDI, taxing
authorities can look to the X12 website at www.disa.org.
The model mappings developed by TIGERS are available at
www.taxadmin.org.

Section 5 - Payment
Options

EFT via ACH

It has been over ten years since the FTA, in
association with the states, developed uniform conventions for
Electronic Funds Transfer (EFT) for the payment of taxes and
associated fees. By 2000, most states are utilizing EFT for many
different business tax types. The form of EFT most widely utilized
refers to debit or credit transactions through the Automated Clearing
House (ACH) network. The ACH network, with its regional sub-branches,
governed by the National Automated Clearing House Association
(NACHA), is the network through which banks exchange funds
electronically for customer transactions. ACH transaction data is
exchanged in strictly formatted, multi-record
transmissions.

ACH Debit

In an ACH debit transaction, the payees
financial institution (in this case the tax authoritys
financial institution) originates the transaction by sending a
request for funds to the payers financial institution (in this
case the taxpayers financial institution). The payers
financial institution then transfers the funds in order to settle the
transaction. The tax authority must receive prior authorization to
request the funds. When a tax authoritys EFT program is not
tied to an electronic return filing program, the tax authority may
use a commercial service for debit origination. A taxpayer generally
calls the debit originator by telephone, and either speaks to a
representative or else utilizes IVR technology to enter the amount of
funds transfer authorized. The originating service then formats the
authorized transaction information into the required ACH format and
transmits it to the taxpayers financial institution.

By 1995, states were interested in combining an
electronic payment with an electronically filed return, into a single
electronic transaction. The EDI standard for the Electronic Filing of
Tax Return Data, transaction set 813, was modified to include
information necessary for ACH debit origination. Several states have
since implemented EDI programs combining the filing and payment in
the 813 transaction. Additionally, provision for authorization of ACH
debit has been added to IVR filing programs and, recently, to the
Fed/State program for Individual Income Tax return filing. When the
ACH debit authorization reaches the tax authority as part of an
electronic tax return transmission, it may be the responsibility of
the tax authority to create the proper ACH formatted records and
transmit them to its financial institution. If the state is utilizing
a Value Added Network (VAN), Internet Service Provider (ISP), or
other third party to process the incoming transactions, that third
party may also perform the ACH debit origination. In this way, the
ACH debit payment is no longer a separate transaction for the
taxpayer, but is folded into the EDI, IVR, or Internet filing
program.

ACH Credit

ACH credit transactions, by contrast, are
originated by the payers financial institution (in this case,
the taxpayers financial institution), and move funds directly
to the payees financial institution (in this case, the tax
authoritys financial institution). Credit transactions are
preferred by many large businesses, who wish to retain control over
the movement of funds from their accounts. Since the taxpayer is
originating the payment, it occurs separately from any electronic
return filing. The EDI 813, or other electronic filing, may contain
notification to the tax authority of the intent to pay by ACH credit,
but the tax authority must wait to receive notification from its
financial institution that the credit payment has indeed taken place.
A third form of ACH payment, the Fedwire, also moved funds directly
from the payer to the payee. A Fedwire moves the funds immediately,
but its data format contains little information about the
transaction. For this reason, most state programs accept Fedwires on
an exception basis only, particularly in the event that a credit
transaction cannot be successfully completed. Current "best
practices" are for a taxing authority to accept both debit and credit
payments within their EFT programs.

EFT Considerations

The most common format for ACH transactions,
both debit and credit, is the "cash concentration and disbursement,"
or CCD. A variation of this format, the CCD+, includes an optional
80-character record which may be used to carry information concerning
the transaction. In the case of simple tax reporting, such as the
coupon accompanying an employer withholding tax payment, it may be
possible to include all necessary information in the CCD+. A
standardized format for tax information, known as the TXP, was
developed by the FTA in 1988 and is widely used for this purpose,
eliminating in many cases the need for a separate data filing. It
should be noted that the EDI transaction set 820, often used by banks
for payment transactions, may also include the TXP record.

One issue that must be noted with ACH debit and
credit transactions is the issue of settlement. The ACH transaction
"settles" when the funds are made available to the tax
authoritys account. Most EFT programs require the funds to be
available to the tax authority on the due date of the associated
return. Because ACH debit and credit transactions generally settle
the next day after they are originated, this requires the taxpayer to
file his return one day early. A paper return and paper check are
considered timely if postmarked on the due date, even though the
funds are not yet available. This discrepancy must be considered by
tax authorities looking for incentives to encourage filing and
payment by electronic means. One such incentive is the ability to
"warehouse" payments until the due date. In this case, the taxpayer
is able to transmit a tax return, including payment information, at
any time, with instructions to warehouse the payment until a
specified later date on or before the due date. This practice
encourages early filing, and may help the tax authority by smoothing
peak filing dates, as well as insuring timely payment. It also
eliminates the advantage of paper to the taxpayer, by allowing the
taxpayer to control the "float" created by the timing of the movement
of funds.

There is another format for ACH transactions,
the "corporate trade exchange" or CTX, which is worth noting. The CTX
allows multiple 80-character records, and is large enough to carry a
complex tax return. Only the larger financial institutions, however,
are able to process the CTX, and it is not widely used for tax
purposes.

Credit Card

As of the year 2000, much debate and
legislative activity has centered around the acceptance of credit
cards for tax payment. The use of credit cards is attractive to both
taxpayer and tax authority. The taxpayer generally gains the option
of utilizing the credit cards revolving payment plan options to
stretch the payment of the tax liability over a longer time period,
while still meeting timely payment obligations. The tax authority
receives the payment in a timely fashion, and may receive payments
from taxpayers who could not otherwise meet their full obligation at
that time. Furthermore, the credit card number and expiration date
can easily be included within an electronic return filing.

Each credit card payment must be authorized and
settled by the card processor. If credit card payments are submitted
in conjunction with paper returns, then the tax authority must
provide staff to authorize the payments, generally by touch-tone
phone into an IVR system. If the payment is denied, the transaction
is generally handled by the tax authority in a similar fashion to a
bad check. In an IVR or Internet tax filing system, the transaction
may be routed directly to the card processor for authorization. If
the payment is denied, the tax authority may accept the return only,
or reject the entire transaction.

The controversial issue surrounding the
acceptance of credit cards for tax payments is the issue of the fees
charged by most credit card processors for handling the transaction.
These fees, commonly called "merchant fees" since they are generally
paid by the merchant accepting the credit card in payment, help to
defray the operating costs of the card processor and some of the risk
of non-payment. The fees are negotiated between the merchant and the
card processor, depending on volume of transactions, and generally
range from 1.5% to 4%. A tax authority which chooses to accept credit
cards is acting in the role of a merchant. The tax authority has
three options for handling the merchant fees or any third-party
processing fees:

To pay the fees out of operating budget
funds;

To pay the fees by deducting the fee
amounts from the tax revenue received; and

To require the taxpayer to pay the merchant
fee on his transaction, by adding a surcharge or "convenience fee"
to the tax payment due.

Option 1 is daunting to any tax authority,
since the merchant fee on millions of dollars in tax payments could
be considerable. Option 2 generally requires special enabling
legislation, because the tax authority is, in effect, collecting less
revenue than is legally due from the taxpayer. The IRS, in
particular, is bound by legislation that requires it to deposit the
full amount due from each taxpayer. Several states, however, have
enacted legislation allowing the merchant fee to be paid from the
revenue stream, justifying the fees on the basis of increased
collections. Option 3, which is being utilized by the IRS and some
state taxing authorities due to legislative requirements, may be a
deterrent to the taxpayer to the use of credit cards.

Tax authorities are also considering the
acceptance of bank debit cards for electronic payment. Like a check,
these payments are deducted directly from the taxpayers
financial institution account. Like a credit card, the funds are
authorized by a card processor, and the tax authority knows
immediately if the payment is good. However, there is a small fixed
fee charged by the card processor.

In summary, there are still issues to be
resolved in the acceptance of debit and credit cards for tax
payments, but they should be investigated by the tax authorities due
to rising customer demand.

Direct Deposit

It should be noted that electronic refund
payments to the taxpayer also benefit both parties; the taxpayer
generally receives the payment more quickly, and the tax authority is
relieved of the need to process and secure paper checks. The most
common form of electronic refund capability is direct bank deposit.
This is generally done as an ACH credit transaction, in which the tax
authority provides refund deposit information to the tax
authoritys financial institution, which in turn passes the
payments to the various taxpayer financial institutions.

Future Payment Options

At the time of this writing, ACH debit and
credit, and the use of debit and credit cards are the commonly
accepted forms of electronic payment. New options, such as the use of
stored-value smart cards, electronic purse options, and "e-cash"
stored with an online processor, are still in the early stages of
acceptance in the community, and are not yet actively considered for
tax payments. It should be noted that in most states, payment options
such as ACH debit and credit, as well as credit card, are controlled
through the State Treasurers Office or other central agency.
Both the selection of supported payment options and the selection of
vendors and vendor interfaces is best done on a statewide level,
providing consistency for the taxpayer and advantages of scale to the
individual state agencies.

In any tax filing which requires payment, there
is the issue of reconciling the data filing to the payment received.
In electronic commerce programs where the filing information is
received through one electronic channel and the payment is received
through a different channel, some mechanism for reconciliation is
necessary. For this reason, programs which integrate the transmission
of filing and payment data in a single transaction provide the best
benefit for the tax authority.

Section 6 -
Electronic Commerce Communications

Two major business issues introduced by the
BTTG Report and Recommendations in 1995 are still relevant in
2000:

How many communications options should a
tax authority support for electronic commerce?

Who should pay any fees or charges
associated with communications of electronic commerce
data?

Communications Options

The 1995 report, concerned exclusively with
EDI, discussed the two primary communications options available to
tax authorities and their trading partners: point-to-point or direct
communications, and the use of Value Added Networks (VANs).
Point-to-point communications requires the tax authority to invest in
sufficient communications hardware, modems, and phone lines to allow
tax filers to dial in directly to transmit their data, even during
peak periods. It also requires the level of technical support
necessary to deal with taxpayer variations in hardware, software, and
technical competence. VANs greatly reduce the need for upfront
investment, by providing communications hardware, phone lines, and
software, generally supporting a variety of protocols and speeds, as
a service. The tax authority needs only to provide the single
connection to the VAN. In 1995, many business taxpayers distrusted
VANs, concerned that a commercial service provider might choose to
misuse its access to confidential business information transmitted
through its systems. Survey results showed that they wanted tax
authorities to offer direct point-to-point communications options.
This was a cause for concern for most smaller tax authorities, who
could not easily afford the investment required for direct
communications, and wished to build their EDI program solely based on
VAN usage.

In 2000, the selection of a communications
option for EDI or other "batch" filing program has been significantly
altered by the availability of the Internet. As businesses "go
online" for other purposes, their Internet connections become
available for tax filing use at essentially no cost, and VANs become
the more expensive option. In many cases, taxpayers are demanding
that tax authorities provide Internet tax filing facilities.
Ironically, however, VANs now are considered "trusted" third-parties,
compared to the risk and uncertainty still present in Internet
communications. VANs, who control their private networks, typically
guarantee a certain level of availability, and often a level of
service delivery. They can be held liable for data that is
misdirected, or fails to reach its destination in a timely fashion.
Internet Service Providers, or ISPs, do not control the Internet
communications channels. For this reason, while the best ISPs
guarantee the availability of their own facilities for connection to
the Internet, they do not guarantee any level of Internet
availability or certainty of message delivery. They cannot be held
liable for failed or misdirected transmissions. Moreover, there is no
guarantee that the Internet transmission will not be accessed by
unauthorized parties. The Internet risk can be considerably reduced
through the use of measures such as message confirmations, firewalls,
and encryption. While the responsibility for these measures generally
lies with the tax authority, some ISPs are beginning to provide them
for their customers, becoming in effect Internet VANs.

At this time, the use of point-to-point
transmission appears to be declining, although there is still
considerable investment in leased lines and dial-up modem banks. Tax
authorities must still decide whether to offer commercial VANs, the
Internet, or both for batch filing initiatives such as EDI for large
Motor Fuel reports. The decision must be based on the relative
concerns for cost versus security and reliability, both on the part
of the tax authority and on the part of the taxpayer.

The tax authority must also determine whether
to offer interactive Internet filing, either through its own website
or through a commercial host, for any tax type. As tax authorities
offer information, forms, and policy documents on the web, tax filing
seems to be a logical progression. Moreover, many states are now
developing web "portals," which allow citizens to access a variety of
personal and business governmental functions in a simple and
user-friendly format. Pressure is then felt by the tax authority to
provide Internet tax filing as a component of the portal services. It
is clear that interactive Internet filing is rapidly becoming a
requirement, as taxpayers demand it, and as security measures become
more widespread. It is recommended that the tax authority survey its
taxpayer base, or hold focus groups, to determine such decision
factors as the level of Internet capability and the degree of concern
for Internet security. Where the customer set is known and limited,
such as the set of registered tax practitioners or a small taxpayer
set such as Motor Fuel taxpayers, the use of "Virtual Private
Networks" (VPNs) is a potential option. The VPN uses encryption and
addressing techniques to create a secure network within the Internet.
The IRS has piloted VPN technology with some success, and it may well
become a "best practice" in the near future.

Another option discussed previously is the use
of IVR systems for tax information and filing applications. Tax
authorities are finding that IVR is a comparatively inexpensive way
to handle simple, low-end returns. In 1995, the question was which
communications options to support for EDI. In 2000, it would appear
that the "best practice" for a service-oriented tax authority is to
offer EDI, either through a VAN or over the Internet, plus
interactive web-based Internet filing, plus IVR. Each of these
channels is suited for a different segment of the taxpayer base, and
work together to cover a full spectrum of filers. However, there are
considerable costs involved with developing and maintaining such a
diversity of programs. Additionally, there are issues related to the
integration of the data from all of these channels into back-end
processing, storage, and retrieval.

Cost Factors

Tax authorities have grappled for some time
with the issue of whether they can require taxpayers to pay fees or
charges in order to file taxes. Since a taxpayer can file by paper
for the cost of postage, filing by electronic commerce must either be
similarly inexpensive, or else provide convenience benefits that
justify any additional cost. Experience has shown that taxpayers may
be willing to purchase tax software to assist in tax preparation and
calculation, but are generally unwilling to pay communications
charges. The tax authority must determine whether the benefits of the
electronic commerce program are sufficient to justify absorbing
communications costs for the taxpayer.

VAN usage generally incurs significant ongoing
operational costs. This is because while both point-to-point and VAN
connections incur phone charges for all but local calls, VANs
generally charge transmission fees based on the volume of data
transmitted, in addition to monthly mailbox fees. Surveys have shown
that of the tax authorities offering VAN-based tax filing programs,
and especially where these programs are mandated, the tax authorities
are paying all transmission charges, and many are also paying for the
taxpayers mailboxes.

In the IVR area, the cost decision takes the
form of whether to offer toll-free service to taxpayers. While many
states do make IVR applications toll-free, others do not. Some
compromise by making IVR general information access toll-free, but
providing the Telefile application on a toll call basis. Others
provide "satellite" IVR systems in major metropolitan areas, in order
to provide local call access, and then use internal networking to
merge the data in the central location.

Cost, then, becomes a large part of the
attractiveness of Internet filing. Internet service providers
generally charge a flat fee for a certain amount of access time per
month. Given that an individual or business generally obtains
Internet access for many more activities than tax filing, that
monthly fee is not associated with the cost of tax filing, which is
considered "free." In particular, cost is a major factor in the
decision whether to utilize the Internet or a commercial VAN for
batch filing, due to the relatively high cost of the VAN.

"Best practice," then, is to make each of the
communications channels which a taxing authority chooses to make
available to the taxpayer as low-cost to the taxpayer as the tax
authority can arrange.

Section 7 - Extensible
Markup Language (XML)

In the 1980s, it was thought that EDI would
become a truly universal language for exchange of business data.
Every business would implement an EDI translator, and therefore would
be able to exchange business document transactions easily and
unambiguously with multiple trading partners. In reality, small
businesses have been reluctant to acquire and install translators.
Moreover, experience has shown that EDI transactions must be
carefully customized between each set of trading partners; for
example, no two states sales tax returns require quite the same
information.

XML Capabilities

A newer technology, Extensible Markup Language
(XML), shows promise of coming closer to the goal of a universal
language for Electronic Commerce. In XML, a "tag" is attached to each
data element within a transaction, giving information concerning both
the semantic meaning of the data element, and also its structure
within the business document. The tags are transmitted along with the
data. Tags are not specified by any generic XML standard; XML is
"extensible" - meaning that the user may extend the language through
the definition of any business document. The Document Type Definition
(DTD), or a similar document definition called a "schema," may be
transmitted along with the data, or stored in a database accessible
by both trading partners.

XML capability is being built into the leading
Internet browsers, eliminating the need for separate language
translators. Any taxpayer with Internet access and a browser can then
interpret the XML by linking to the database server containing the
document definition. Additionally, an XML transmission can be
associated with a "style sheet" indicating how the data is to be
displayed and manipulated by the browser. In this way XML allows the
taxing authority to create an Internet filing application, control
how the taxpayer interacts with the application through the browser,
and specify unambiguously the meaning and structure of the data
within the tax return

Current Status

XML is an emerging technology, which is not yet
mature. A number of competing business consortiums are proposing
formats for the document type definition or schema, and are vying to
be the primary repository for common business document definitions.
Only the latest browser releases support XML, and performance may be
an issue with smaller hardware. In mid-2000, only one or two actual
implementations of XML for tax filing can report experience. However,
the level of resources being invested in XML development promises
that XML will become a best practice in the near future. XML is
already in use in commercial online catalog applications, and is also
being used in back-end systems integration to communicate between
unlike enterprise applications.

Several different organizations are working to
develop a prototype DTD or schema for a tax return. The TIGERS
workgroup has begun this effort, in liaison with vendors and other
interested organizations. The goal is to develop XML definitions that
can be provided to software developers, whether within the taxing
authority or outside third parties, for use in constructing dynamic
EC applications.

PART III - NEW ISSUES
FACING TAXING AUTHORITIES

Section 1 - Marketing
of EC programs

Marketing is not a traditional strength of tax
authorities. Accustomed to issuing regulations based on legislative
mandate, tax authorities often falter when faced with the task of
encouraging participation in voluntary programs. To compound the
problem, tax authorities in the early to mid-1990s believed
that the benefits of electronic commerce solutions, such as
electronic filing and EDI, were so clear and compelling that
taxpayers would naturally adopt them. The results of this "field of
dreams" approach - "build it and they will come" - were universally
disappointing. It has become painfully obvious that a Tax Authority
must aggressively market its electronic commerce capabilities in
order to maximize the benefits inherent in migration to a paperless
processing environment. Presentation of e-commerce benefits must
repeatedly be made available to a variety of specific market
segments. Only after customers are made aware of the benefits to
themselves will they begin to investigate the possibility of
participating in a voluntary (non-mandated) electronic commerce
program with Tax Authorities. Awareness messages must be concise,
complete, repeated, and specific to an area of the customer
base.

A variety of approaches must be investigated to
maximize resources devoted to marketing activities. What works best
for one market segment (individual tax filers) may have no impact or
bearing on another (large corporations). A Tax Authority must first
inventory its own electronic capabilities and identify and prioritize
segments which offer the best potential for growth. Identification of
the Authority's suite of capabilities should aid in determining
appropriate target segment areas for marketing in order to achieve
maximum impact. Identification and prioritization of market segments
can serve to show areas which offer the best potential for maximizing
government resources to expand existing or introduce new e-commerce
applications.

Marketing Approaches

Commercial advertising is growing beyond the
financial reach of most tax authorities. Because of this limitation,
creativity must be used to develop effective marketing programs.
Specifically, the following activities, derived from a variety of
existing and potential tax authority marketing programs can be
considered the Best Practices which may be implemented and/or adapted
to the individual Authority's situation.

Become Familiar With Customer Capabilities
and Constraints: Doing so allows the tax authority to identify
areas which will be of benefit to the tax paying customer and
which can serve as selling points. Conduct focus group interviews
and panels and individual contacts in order to derive as much
information as possible to determine strengths and weaknesses of a
program's customers.

Identify Specific Market Segments and
Specific Benefits for Each: This activity allows the tax authority
to target the message to a specific customer.

Identify the Optimal Media to Be Used To
Disseminate the Message to Each Audience: Radio and television
public service announcements, may reach a specific audience which
is not inclined to read tax related printed materials.

Leverage All Taxpayer Communications As
Opportunities For Delivering the Message: Put the electronic
commerce message prominently displayed on tax booklets, notices of
adjustment, announcements of regulation changes, all press
releases - regardless of subject matter - and even refund checks.
Form partnerships with businesses to insert electronic filing
messages into W-2 distributions. Utilize non-tax-related mailings
such as "stuffers" in electric bills.

Maximize Information Availability: Repeat
the message as frequently as possible in as many ways as possible.
Provide consistent information about the benefits the customer can
derive by making use of the Tax Authority's proven
capabilities.

Emphasize Success and Advantages for Other
Potential Program Participants: Quote numbers, if available,
demonstrating advantages to existing customers who use the
program. For example, "300,000 of New York's taxpayers may be
receiving their tax refunds faster than you are!" or "20,000 Iowa
businesses are saving themselves money by filing their sales tax
returns electronically!", etc.

Offer Incentives to Users of E-Commerce
Programs: If legally allowable, a tax authority should offer as
many incentives to its e-commerce customers as possible. Such
incentives may include, but are certainly not limited to, tax
credits and delayed filing deadlines.

Share Information: Tax authorities should
become familiar with and maintain a knowledge of marketing
programs being used by neighboring authorities (to provide
consistent messages) and at the federal level (contact the IRS
e-File coordinator servicing the area). Participate in and share
information with peers through use of such groups as the Tax
Information Group for E-Commerce Requirements Standardization
(TIGERS).

Marketing to Service
Providers

In addition to the taxpayer customer, tax
authorities need also market to service providers, such as the tax
preparers and software vendors whose products are needed to support
state filing programs. While a state may choose to outsource an EC
program to a selected service provider, on a fee basis, this is
rarely an exclusive arrangement. Tax authorities need the support of
the big-name players in the tax compliance field, both in the
individual and the business marketplace.

Request For Agreement: The Request
For Agreement, or RFA, whether formal or informal, is a best
practice in marketing to service providers. In return for adding
the state program to the product or service, the tax authority
agrees to feature the service provider on the tax authoritys
website, provide a link to the vendors own website, use the
vendors logo, or some other comparable "in kind" provision.
This is multi-level marketing: the tax authority aids in marketing
the service providers offering, which in turn reaches
potential customers for the tax authoritys program that the
service provider supports.

Be aware of service providers
calendars and time considerations. For example, tax preparers are
setting up their programs in the fall, while tax software vendors
are already designing their next software releases in the
spring.

Section 2 - Who
Provides the Program?

One of many new issues facing Tax
administrators in the Electronic Commerce arena concerns who provides
the products and/or services, generally computer software, that
comprise the EC program. For taxpayers to adopt an EC program, it
must be inexpensive, efficient, effective, and available. For the tax
authority, those criteria must guide its choices among three
alternatives:

Build the program in-house and offer it at
no cost to the taxpayer

Contract with a third party to develop the
program, so that the taxing authority pays the third party for the
development and there is again no charge to the taxpayer,
or

Allow service providers to support the
program voluntarily, motivated by competition in the marketplace,
and potentially charging a fee for use to the
taxpayer.

Based on tax type, vendor availability, and
taxpayer base, the "best practice" for a taxing authority may be a
combination of all three approaches.

In-house vs Market
Development

The piece that actually interfaces with the
taxpayer is the front end software or Internet application used to
enter the return information and transmit it to the taxing authority.
Issues about who and how to develop this component of the program
lead to an interesting dilemma for tax agencies. Should the agency
develop this software or Internet application themselves, or should
they leave this up to the free-enterprise market and certify vendors
of software and/or Internet products? Is there enough of a market for
a software or Internet product to justify private vendors offering
solutions for this component? The actual size of the taxpayer base
for specific taxes may be the determining factor for this question.
In the individual income tax arena, the free market competition model
has served the taxpayer well. Taxpayers can choose from a variety of
programs, both practitioner-assisted and those for the home computer,
as well as Internet-based offerings. Competition has steadily driven
down the cost of programs and services, to the point where vendors
offer free online filing to taxpayers below a certain income
threshold. In a state sales tax program, where the taxpayer base is
in the thousands of taxpayers, vendors of software and/or Internet
products will probably be interested in developing solutions for the
program. On the other hand, for taxes with significantly smaller
numbers of taxpayers, there may not be a large enough market to
justify a private vendors decision to develop a product. In the
latter case, a taxing authority must determine the most cost
effective means to develop an appropriate program and make it
available to the taxpayers.

Other factors which may come into play
include:

Product support - Software products and
Internet applications must be supported at a level so that
taxpayers can get help when it is needed

Product features - A competitive
marketplace can benefit the taxpayer by leading vendors to add
attractive ease of use features that may take resources beyond the
reach of a tax authority

Product maintenance - legislative activity
can mean changes have to made quickly to software or Internet
programs

Security - can a private vendor meet
security/confidentiality requirements for the agency ?

This issue has become particularly sensitive in
light of the pressure on tax authorities to offer interactive
Internet filing applications. Where there is an established market,
such as the individual income tax practitioner networks, in-house
development of these applications is seen as a threat to that
markets very existence. At the same time, the tax authority
must face citizen demand for low- or no-cost solutions. While tax
authorities must decide on a case-by-case basis whether in-house
development is justified, they should be aware that their actions may
generate strong reactions from the service provider
market.

Outsourcing

As taxpayers demand multiple electronic
commerce channels, such as IVR, EDI, and both batch and interactive
Internet access, it becomes less and less likely that the tax
authority will have sufficient resources in-house to support all of
these programs. For each new program, the tax authority must ask
itself, does the tax authority have sufficient training and resources
to develop and administer all aspects of the program in-house, or
should certain components (or maybe all components) of the program be
outsourced to the private sector? Considerations for making the
outsource decision include the following:

Cost/benefit - is it more economical for
the agency to acquire the resources for web servers, translation
software, support personnel, etc? Or is it more feasible to
outsource those pieces?

Volume of transactions - does the agency
have the communications hardware and software to handle receiving
the volume of files/Internet transactions from all different kinds
of platforms/communications protocols that taxpayers may be
using?

Time - how quickly does the program need to
be up and running? Can the agency meet the mandated project
timelines?

Security - can an outside vendor provide
necessary security for tax data transactions? Does the agency have
mandated/legislative confidentiality criteria?

These decisions should be made as part of an
overall implementation strategy, rather than as piece-meal reactions
to each EC program.

Section 3 - Customer
Relationship Management

Although Electronic Commerce, in all its forms,
has continued to grow from the 1990s into the year 2000, an
additional focus for the new century is Customer Relationship
Management (CRM). CRM systems tie together all of the various
electronic channels for communicating with the customer &emdash; in
the case of a taxing authority, this is generally the taxpayer
&emdash; into a consistent, complete, electronically based taxpayer
relationship. While the full implementation of CRM is not yet
widespread, it is recognized as a "best practice" in those agencies
which have been able to implement the new technologies.

On the front end, CRM ensures that the taxpayer
receives accurate, consistent account information whether by
Internet, IVR, paper mail, or telephone call to a taxpayer assistance
specialist. Careful channel management is needed to keep multiple
sources of information in synch at all times. Current CRM practice
works hand in hand with tax EC to emphasize taxpayer self service and
account self-maintenance. However, CRM best practices recommend that
a taxing authority provide information, account maintenance, and tax
filing in the manner that each taxpayer finds most comfortable
&emdash; a restatement of the "one size doesnt fit all"
determination encountered through EC experience. CRM best practices
also ensure that a taxpayer always has a means to communicate a
specific message or request to a live person, from any self-service
application. Examples of this option include a "transfer-out" key
within IVR programs to allow a taxpayer to transfer out of the
interactive voice application to a telephone extension of a taxpayer
assistance unit. A similar example is the ability to send active
e-mail to the tax authority during an interactive Internet filing
session, or from the taxing authoritys website. The taxpayer
assistant may respond via e-mail as well, or by another channel if
appropriate; although there are a growing number of means for
creating secure e-mail, taxing authorities as yet do not allow the
disclosure of confidential taxpayer information over Internet
e-mail.

On the back end, CRM systems track the history
of the taxpayers relationship with the tax authority. A
comprehensive CRM system provides access to taxpayer e-mails, images
of paper correspondence, summaries of telephone contacts, as well as
filling history and account status. Such systems are designed to
support the customer "contact center," an outgrowth and enhancement
of the customer call centers of the 1990s. Where a call center
centralized the telephone-based taxpayer assistance function, the
contact center provides a centralized facility for handling
telephone, e-mail, and paper-based requests for assistance. A contact
center specialist having the complete history of a taxpayers
interaction with the agency, in electronic format at his or her
fingertips, is much better prepared to resolve the taxpayers
need quickly and correctly, without need for additional follow-up.
CRM systems are also useful to auditors and revenue officers in
working with taxpayers to resolve compliance issues. CRM system may
also allow a taxing authority to distinguish between contact types,
and to set up specialized services for tax practitioners and other
third-party intermediaries.

CRM systems represent a considerable investment
on the part of the taxing authority. The most sophisticated systems
require the integration of telephone and data infrastructure, in
order to provide the contact center staff with the complete
computerized taxpayer history as soon as the taxpayers call is
received. It should be noted that the creation of a true contact
center may also have significant organizational impact on a taxing
authority. Contact center staff must acquire new skills in telephone
call handling and writing skills for both paper and electronic
correspondence, as well as CRM applications knowledge.

Section 4 &emdash;
Enterprise Initiatives

This report is primarily concerned with
Electronic Commerce between a taxpayer and a taxing authority, with
special emphasis on electronic filing of tax returns. However, tax EC
is one part of the larger picture of governmental EC. Each taxpayer,
whether individual or business, must interact with a variety of
governmental agencies at the federal, state, and local levels. A
number of initiatives have been undertaken to allow the taxpayer to
conduct Electronic Commerce with multiple governmental entities in a
simplified transaction. These initiatives fall under the general
categories of portal applications and combined filing
programs.

Portal Applications

A "portal" is an Internet application which
serves as a gateway to a number of other Internet applications,
arranged in an intuitive fashion for easy customer access. Portal
initiatives are underway in a number of states, to provide citizen
access to state and local agency functions over the Internet. These
initiatives are based on the premise that a citizen does not
generally know, or care, exactly which agency provides which function
within an often bewildering array of licensing, filing, and reporting
requirements. Portals are generally arranged from the citizens
point of view, into desired actions such as "license my car" or
"start a new business." The citizen enters information online, and
that information is transmitted by back-end applications to the
correct governmental agency or agencies. Attempts are generally made
to have the same "look and feel" across all portal applications, and
to incorporate various ease of use features.

Taxing authorities who have invested time and
resources in building informative websites and interactive filing
applications may be faced with the challenge of incorporating these
applications into a state portal. The most common approach is for the
portal simply to link to the taxing authoritys website and
filing applications from its selection screens, without actually
taking over these applications. The taxing authority may be
encouraged to adopt the look and feel of the portal; best practices
recommend that the tax authority embrace the portal concept and
identity for the overall ease and convenience of the taxpayer
citizen. On the other hand, a tax authority which has not had the
resources to build sophisticated information and filing Internet
applications may receive significant assistance from a well-supported
portal initiative.

Combined Filings

It is often necessary for the citizen to
provide essentially the same information to multiple governmental
entities, often at multiple levels of government. A number of
initiatives have been undertaken to allow the citizen to provide the
information electronically one time, and let back-end systems
distribute that information to meet all filing requirements. One
combined EC application which is growing in popularity is that of
business registration. This "one-stop shop" application allows a
business to enter all of the information needed for registration and
licensing one time, generally through an Internet portal. That
information is then forwarded to the taxing authority to register the
new business for all applicable tax types; it is also forwarded to
the Secretary of State, local licensing boards, and all other
appropriate authorities.

Another application which lends itself to an
enterprise approach is that of business wage and tax reporting. A
business must report essentially the same information for federal and
state tax withholding, for unemployment insurance, and to the Social
Security Administration and Department of Labor. An initiative known
as the Simplified Tax and Wage Reporting System (STAWRS), sponsored
by the Internal Revenue Service, has begun to encourage pilot
projects to combine these multiple filings. The business files all
required information with one agency, which in turn distributes the
information as required. It is the intent of the STAWRS program to
accomplish this combined filing through Electronic Commerce. A number
of state taxing authorities are working with the STAWRS pilot
programs.

Section 5 - Legal and
Compliance Issues

Record Keeping

A taxpayer is responsible for maintaining all
records that are necessary to determine the taxpayers correct
tax liability. The tax authority is responsible for maintaining
records of tax returns filed, according to a statute of limitations.
Electronic Commerce does not change any of these basic requirements.
It merely changes the form of many of those records, from paper to
electronic.

Electronic record-keeping requires conscious
planning, especially for the individual or small business taxpayer.
Care must be taken not to lose years of tax records when a personal
computer is traded in on a newer model. Additionally, records must be
converted periodically to newer technologies in order to maintain
their accessibility &emdash; for example, how many tax records still
reside on 5 inch floppy disks?

Record-keeping becomes critical in questions of
"due diligence," where the taxpayer contends that everything
necessary was done to complete the electronic transaction, but the
tax authority contends that it did not receive the electronic return
or payment. Tax authorities must make clear to both individuals and
businesses what information - such as confirmation numbers and
transmission logs - must be maintained to meet standards for due
diligence in the electronic world. The FTA EDI Audit and Legal Issues
Task Force has drafted a "Model Recordkeeping and Retention
Regulation," which has been adopted by a number of states.

Signatures

Signatures serve multiple purposes in the paper
world, including authentication that a taxpayer is who he says he is,
and assurance that a tax return as filed is a true and accurate
representation (non-repudiation). These same purposes must be served
in Electronic Commerce. By far the most common form of signature in
use in tax EC is the Personal Identification Number, or PIN. PINs may
be issued easily to large populations, either by mail or, in the case
of interactive programs such as Telefile and Internet applications,
by allowing the taxpayer to choose a PIN. The taxpayer then enters
the PIN to log onto a tax filing program, to gain access to his or
her account status, or to "sign" a completed return. For most tax EC
purposes, PINs appear to suffice. However, PIN notices may be stolen
from the mail, and PINs may be forgotten or lost. Tax authorities
should take care not to require a taxpayer to maintain and remember
multiple PINs for multiple filing requirements.

Digital signatures offer an added degree of
protection, particularly for Internet transactions. In addition to
identification of the taxpayer, a digital signature ensures that the
EC transaction has not been tampered with or altered. However, a
digital signature is in essence a software program and an encryption
key file, known collectively as a digital certificate, which must be
successfully installed on the taxpayers computer. Digital
certificates may be obtained for a fee, from commercial certificate
authorities. Tax authorities are just now beginning to consider
becoming certificate authorities themselves, and issuing digital
certificates to business taxpayers upon registration. Clearly digital
signatures are not appropriate for use with simple programs such as
Telefile. At this time, it is not practical to require individual
taxpayers to acquire and install digital certificates. However,
future applications may provide some form of electronic
identification for individual taxpayers, possibly in conjunction with
the ubiquitous state drivers license.

Enabling Legislation

The majority of states have now passed some
form of Electronic Commerce Act, which ensures that records and
signatures cannot be denied force of law merely because they exist in
electronic form. Best practices are for these laws to be technology
neutral, that is, not to prescribe that any specific technology be
used for either electronic records or electronic signatures. Model
legislation for this purpose has been drafted by the National
Conference of Commissioners on Uniform State Law, and is known as the
Uniform Electronic Transactions Act (UETA). Senate bill S.761,
recently signed into law, provides that state law conforming
substantially to UETA will not be overridden by federal legislation.
As of the writing of this report, the federal legislation is too new
to fully assess its impact on the states, or on the use of digital
signature technology.

Enabling legislation may also be needed in the
area of tax payments. As discussed previously, some states are
enacting legislation to permit them to accept credit cards in payment
of taxes, paying the required credit card fees from the revenues
received. Tax authorities accepting credit cards must become aware of
the laws and regulations surrounding credit card use, such as "Reg E"
which limits an individuals liability if a credit card is lost
or stolen.

The most controversial area of legislation in
tax EC is the issue of mandates. The majority of states have mandated
that certain classes of taxpayers, generally those with high
recurring tax liability, must pay that liability using electronic
funds transfer (EFT). Only a few states, however, are mandating that
those taxpayers must also file by electronic means. States should
consider mandates carefully, to ensure that those taxpayers mandated
to electronic commerce have the means to comply without suffering
undue economic or other burden.

Supporting Documentation

The original IRS e-file program required the
taxpayer to send a paper signature document, plus supporting
documents such as W-2s, by mail to the IRS, The paper documents were
then manually keyed into computer systems, and the paper stored. The
requirement to data enter and store paper supporting documentation
negates much of the benefit of electronic filing. It is burdensome to
the taxpayer, the tax preparer, and the tax authority. Today, PINs
replace paper signatures, and the responsibility for maintaining
W-2s rests with the taxpayer or tax preparer in many EC
programs. Tax authorities should choose manageable alternatives to
ensure that an Electronic Commerce program is in fact
paperless.

Part IV -
ELECTRONIC COMMERCE ISSUES REVISITED

This section revisits each of the issues raised
in the 1995 BTTG Report and Recommendations, updating the
recommendation to reflect the status of 2000. Where the issue may
have addressed EDI exclusively in 1995, it has been updated in 2000
to address multiple electronic commerce (EC) channels. Additionally,
the issues have been expanded to cover individual as well as business
tax applications.

1. What are tax filers EC
capabilities?

Most businesses have touch-tone telephones,
and are therefore capable of Telefile if appropriate. While most
individual filers also have touch-tone telephones, there are still
rural areas that only have rotary service. A growing number of
businesses have Internet access, although there is still a great
deal of concern for security and reliability of the Internet for
tax filing. Recent surveys indicate that household penetration of
Internet connection is roughly 30% - 50%. In general, most
businesses do not have EDI capability for tax filing - even if the
business uses EDI for bottom-line functions, the tax department
may not have access to this functionality. EDI capability must be
supplied by the tax authority except for the largest taxpayers. In
general, individuals have no need for EDI capability.

2. Should electronic tax filing programs be
implemented through administrative rules and regulations or
through statutory legislation?

Electronic filing programs should be
implemented through administrative rules, to provide flexibility
for the tax authority. The one exception is in the case of a
mandated program, which must be implemented through legislation.
In that case, the legislation should be as flexible as possible,
such as reference to a liability threshold to be prescribed by the
agency Director. Adoption of uniform or model statutes, such as
the Uniform Electronic Transactions Act, are
encouraged.

3. Should tax authorities employ the use of
Trading Partner Agreements or administer electronic filing
programs for business taxes through the use of administrative
rules?

As a rule, tax filing programs are one-way
directed, so that the tax authority has the ability to specify the
parameters of the program. For this reason, traditional trading
partner agreements are generally not necessary. In most cases,
business taxpayers are required to register for electronic filing
programs. The signed registration document, with acknowledgment of
the program rules, can serve the function of the trading partner
agreement.

As a rule, tax authorities are not offering
incentives for their electronic filing programs, on the theory
that the efficiencies of the program provide benefits to the filer
as well as to the agency. For example, the "rapid refund" has long
been the primary incentive for Individual Income Tax e-file. The
most common incentives that are offered affect filing and payment
due dates, such as a delayed due date for electronic filing, or
the ability to file at any time but have the payment "warehoused"
until the due date. Any monetary incentives, such as a discount
for electronic filing, will probably require legislative approval,
but they may be effective for larger business filers. It has not
been conclusively proven whether or not such incentives are
effective.

5. What should be the records retention
requirements for EC-based tax related documents and associated
data?

The retention for electronic documents
should be the same as for the equivalent paper document. The FTA
Business Task Group has developed a model records retention
regulation which has been adopted by many states. Current "best
practices" are for taxpayers and tax preparers to maintain
signature documents, W-2s, and other supporting paper documents,
rather than submitting them to the tax authority, in order to
maintain a completely electronic filing process. The majority of
states have now passed Electronic Commerce Acts which ensure the
legal status of electronic records and signatures. Note that both
tax authority and taxpayer must maintain the hardware and software
necessary to access the electronic records, until the statute of
limitations has expired for those records.

6. Should EC-based electronic tax filing be
mandatory or voluntary?

Experience has shown that mandating may be
necessary to reach the desired level of participation. As a rule,
only the taxpayers above a specified threshold should be mandated
to use electronic means. However, smaller taxpayers could be
mandated to use a simple and widely available technology such as
Telefile.

7. What education and EC tax filing support
should the tax authority provide?

The support for electronic commerce programs
should be at least equal to the support provided for the
equivalent paper programs. A "help desk" or "contact center" for
taxpayer support is a best practice, and staffing for evenings and
weekends during peak filing seasons should be considered. Where
the tax authority is supplying software to the taxpayer base, then
additional technical support should be made available. The tax
authoritys website should be used to provide Frequently
Asked Questions and to allow e-mail inquiry. The tax authority
should set target goals for turnaround of taxpayer
questions.

8. How much lead time would be necessary
for the taxpayer to implement an EC-based electronic tax filing
program?

The lead time for the taxpayer to implement
an electronic tax program depends on the channel used. A taxpayer
with a touch-tone phone or Internet access can participate in a
Telefile or interactive Internet application immediately, with no
additional implementation required. If the tax authority supplies
EDI-based PC software, installation of the program could take one
to two weeks. If a taxpayer is implementing native EDI with
multi-purpose EDI software, or utilizing a tax compliance package
with an EDI facility, the implementation could take up to six
months.

9. Should multiple EC transmission filing
options (original: point-to-point, use of a VAN, magnetic media,
FTP) be offered by the tax authority for batch filing programs
such as EDI?

Point-to-point capability is expensive to
develop and to maintain, and is probably to be avoided in light of
the alternatives available today. The costs of VAN use have been
cited as the greatest obstacle to EDI. Tax authorities should
decide, based on economics as well as taxpayer demand, whether to
support a VAN connection, use of the Internet, or both. Tax
authorities should seriously consider the use of IVR and
interactive Internet technologies.

10. How should weekend and holiday due
dates be handled?

Weekend and holiday due dates should be
handled in accordance with Federal Reserve requirements, that is,
the transaction must be initiated to settle the next business day
after the weekend or holiday. It should be noted that IVR and
Internet transactions, which are generally available 24 hours per
day, seven days per week, could be initiated even on a weekend or
holiday. The transactions would then be processed by the tax
authority on the next business day.

11. What constitutes due diligence, timely
filing, and proof of filing for the electronic filing of tax
return data?

All electronic filings should be
acknowledged in such a way as to provide a proof of filing for the
submitter, whether the actual taxpayer or an electronic return
originator (ERO). This may take the form of a traditional EDI
acknowledgement, or may be a confirmation number in the case of
Telefile or interactive Internet filing. While the tax authority
should attempt to minimize potential failure points in the
technology infrastructure of the electronic filing program,
breakdowns will occur. Generally, if an outage occurs which is not
the taxpayers fault, a grace period should be offered for
penalty or interest for late filing.

12. Will an original signature be required
for each electronic tax return filed?

Note that many paper filings, such as most
monthly sales tax returns, do not require a signature on each
filing. In general, a single signature on file should be
sufficient for repeated regular filings. Some form of PIN or
identification code may be required for security and
authentication purposes, and may be repeated as a form of
signature, especially on infrequent filings. Although public key
encryption-based digital signatures are currently the most
reliable form of electronic authentication, it must be noted that
in a business environment, they generally identify a computer
server, rather than an individual.

Where third-party service providers are
utilized, the tax authority should contractually bind them to
liability for deliberate or accidental disclosure of confidential
data. In the case of an interactive Internet application, the tax
authority should make reasonable effort to secure the return data
against hackers, by such measures as firewalls, encryption, and
removal of the data at regular intervals to an offline process.
Note that the electronic return, like the paper return, is not
legally the responsibility of the tax authority until it is
received.

14. What uniform methodology will tax
authorities employ to ensure that what the tax filer sent was what
the tax authority received (integrity) and that the tax data sent
actually came from the tax filer (non-repudiation)?

At this time, PINs and confirmation messages
are the most pervasive methodologies in use. While public key
encryption and the use of digital signatures provides superior
proof of integrity, its use is still somewhat limited.

15. Should electronic payments and
electronic return data be transmitted in the same
transaction?

While there are definite advantages to the
tax authority in transmission of both payment and return together,
in the elimination of reconciliation, multiple options should be
offered to the taxpayer. In a large corporation, the tax filing
may come from one department, while the payment may come from
another, limiting the corporation to filing a return with a
remittance advice, rather than actual payment. Additionally,
separation of filing date and payment date ("file now, pay later")
may serve as an incentive for electronic filing.

16. Should tax authorities develop
registration and software testing criteria for tax filing
intermediaries who wish to transmit tax filing information on
behalf of their clients?

All software vendors should be required to
pass some form of certification testing, such as the correct
transmission of a number of test returns, before that software is
accepted for filing. It is also useful for tax preparers using
that software to send a test transaction, but is not as critical.
Business taxpayers are generally encouraged to send a single test
return, generally the previous months filing, as part of the
registration process. If the taxpayer is also paying by EFT, a
prenote transaction is generally required. It is not practical,
however, to require test transactions from individual
filers.

17. Should standard geographic, industry,
and other identifying codes recognized as standard approaches be
used by tax authorities in their electronic filing
programs?

If standards are established in a given
technology, then they should be utilized. For example, EDI
programs should be designed to comply with mapping conventions
established for various tax types, such as Motor Fuel. Where
standards are just being developed, such as in XML for Internet
use, effort should be made to coordinate with others attempting to
use the technology. The TIGERS group serves as a focal point for
data standards development. The use of standards is of particular
value to software developers and service providers, who may not be
able to justify widely differing versions for different
jurisdictions.

Yes, with the recommended methodology being
a downloadable format on the tax authoritys website. In the
EDI environment, transaction set 150 is designed for this purpose,
but currently is little used.